On November 5, 2009, Fannie Mae launched what they characterize as a Deed-For-Lease in lieu of foreclosure program. The program allows a financially-distressed homeowner who does not qualify for a loan modification to stay in his home as a tenant by exchanging title to his property for a one-year lease agreement. The program does not include a repurchase option.

To qualify, the homeowner must currently occupy the property as his primary residence and deliver title to the property clear of any liens junior to the Fannie Mae loan. Rent under the program is capped at 31% of the homeowner’s pre-tax income, with lease agreements for periods up to 12 months with a renewal or extension on a month-to-month basis. If the home is sold during the term of the lease, the buyer takes title subject to (“inherits”) the lease.

This program aims to alleviate the deterioration of neighborhoods caused by vacant properties and foreclosures, and to soften the financial and social impacts of a homeowner losing his house.

first tuesday take: At last the government, through its mortgage arm Fannie Mae, is getting realistic with negative equity homeowners in California, most of who do not qualify for modification as they are at loan-to-values (LTVs) in excess of 125%. Fannie Mae could not previously admit to the obvious: take a deed-in-lieu of foreclosure, and if it could not instantly be resold as a real estate owned (REO) property, lease back the property to the homeowner who could/would not pay on the loan. However, the government agency must still foreclose on homeowners who have second liens on their homes in order to convey title to the property on resale as an REO.

This is a meritorious step forward for a lender and but a simple variation of the short sale of the property negotiated by the homeowner and his agent. Under the deed-in-lieu program, the lender, not the owner, is required to find the buyer at current market prices. Stranger conduct by lenders has been observed, specifically the refusal to process short sales (since allowing the discount of the loan on a payoff is anathema for poker-faced lenders).

We will see prices bottom sooner under this type of program as properties (which are currently being withheld) are sooner placed on the market. However, the process will still elongate the recovery of the real estate industry from its deep-rooted recession. The reason: after the one-year lease period is up, properties will be dumped onto the market at a time the market would otherwise be going into a recovery or a sales volume upswing.

This sale lease-back situation will provide flexible agents and brokers an opportunity to earn a fee for negotiating the exchange of the title for the lease agreement. This sale-by-exchange for the leaseback will be part of the consideration given the homeowner for title to the deed-in-lieu documentation. Since no foreclosure took place, the homeowner did not suffer the social embarrassment of foreclosure or receive a ding on his credit score. However, lenders are quick to ask a homeowner about entering into a deed-in-lieu arrangement.

MLS inventory is replete with short sale candidate properties which are underwater way more than 25% and thus are ineligible for loan modification (which modifications typically see a re-default within six months, as has been the history of such “extend and pretend” programs). Most of these homes are presently owner-occupied and a large percentage of them are Fannie Mae loans. For the properties which fit under this criteria and have no junior trust deeds on title, listing agents can facilitate the erstwhile homeowner’s negotiation with the lender for the one-year lease. Then, during the year, the same agents can assist the ex-owner/tenant in finding a new property to purchase.

Further, the homeowner may have an investor-buyer who would have done a short sale acquisition of the property and would, concurrently with the deed-in-lieu/leaseback transaction, be willing to acquire the property from Fannie Mae subject to the lease agreement. The rental income schedule under the lease agreement would then be used to capitalize and set the value and price to be paid for the property.

We see fees for brokerage services at every turn in this program – if it ever hits the ground. We hope this one is a breakaway from past save-the-owner programs. Most of those have been dismal failures in the financial restructuring of California hundreds of thousands of underwater homeowners.

The next government-sponsored program needs to grant bankruptcy judges the authority to cram down loan balances to current market values so that homeowners can both stay in their homes and own them into the future. This would force lenders into fast action to make the adjustment in loan balances before the judges get to them. But most importantly for California’s economic growth, the homeowner would be able to stay put without the burden of a dead-end loan, negative personal net worth or the total inability to contribute to the consumer economy during the next ten years (which would be the situation if he irrationally decided to remain in the home and pay, pay, pay). If he stays-and-pays, he will need a flush of a different and more royal sort. [See first tuesday Forms 406, 472 and 550]

Re: “Avoid foreclosure: rent your own home” from CNNMoney.com